Op-Ed: How the big banks rigged the market

By:  Philip Stephens
The Financial Times

When Lloyd Blankfein met politicians in London a little while ago he brushed aside warnings that investment banks faced higher taxes if they ignored the rising public outcry about multibillion-dollar bonus pools. The Goldman chief executive seemed to believe governments would not dare.

That misjudgment – a measure of the breathtaking hubris that, even after all that has happened, continues to separate bankers from just about everyone else – may explain Goldman’s response to the British government’s decision to apply a 50 per cent tax to this year’s payouts.

In the description of Whitehall insiders, Goldman executives reacted with anger and aggression. The threat was that the bank would scale back its business in London. For a moment it seemed Gordon Brown’s administration might wobble. In the event, Goldman’s lobbying failed to persuade it to soften the impact of the tax.

Britain, of course, is not alone. France has imposed its own bonus tax. Barack Obama’s administration has just announced a levy to recover an estimated $90bn (£55bn, €63bn) over 10 years. The centre-right government in Sweden has gone further by introducing a permanent “stability levy” to discourage excessive risk-taking.

It is a measure of how far the political debate has shifted against the financial plutocrats that George Osborne, the Tory shadow chancellor, has applauded the Swedish plan. If the Tories win the coming general election, they would support a worldwide levy along similar lines. It is “unacceptable”, Mr Osborne remarked the other day, for the banks to be paying big bonuses rather than building resilience against future crises.

So far, so encouraging. But the process cannot end here. Irritating as it may be to Mr Blankfein, a one-off bonus tax is not going to change anything in the medium to long term. Levies such as that in Sweden mark a recognition that the profits and remuneration policies of the banks are more than a fleeting problem. But forcing bankers to strengthen balance sheets with money they would rather put in their own pockets addresses only part of the problem.

The next stage must be scrutiny of the structural distortions that allow these institutions to rack up such huge profits. Broadly speaking, the leading players in at least three areas of investment banking – wholesale markets, underwriting and mergers and acquisitions – have been operating natural oligopolies.

Their profits have been in significant part a reflection of the absence of robust competition. There are different reasons for this in the different areas of business – what economists call asymmetries in some and market dominance in others. But as long as they are not addressed, the banks will make profits – or more accurately, extract rents – out of all proportion to any contribution they make to the wider economy.

During the good times no one worried too much about these oligopolies. Markets were booming and the investment banks persuaded policymakers that they made a big net contribution to economic dynamism. That myth has now been exploded.

The absence of sufficient competition has been raised by Lord Turner, the chairman of Britain’s Financial Services Authority. He has suggested a transaction tax to deal with the problem in wholesale markets. Christine Lagarde, France’s finance minister, has recently circulated a more detailed paper to governments and regulators. But too many policymakers have so far ducked the issue.

Even if the banks can be forced to take fewer risks they will likely continue to make excess profits. The issue is one of competition rather than regulation. A possible answer might be a move by competition authorities to lower barriers to new entrants. More likely, a serious examination would conclude that the excess profits are best dealt with through taxation.

Many in Mr Blankfein’s world want to pretend the backlash against the banks is a conspiracy between the mob and populist politicians. They hope, and expect, the pressure will go away when prosperity returns.

Tax and regulation should not be used as weapons to settle scores, however tempting that might be. But the banks have had it too good for too long; and the rest of us are now paying the bill. Institutions in the vanguard of spreading liberal market economics around the world were all the while making fortunes in markets that were rigged to their advantage.